Page 1PricewaterhouseCoopers
Three Talks in One*
Building Public TrustValueReportingEnterprise Risk Management
Energy Insurance Mutual Risk Managers Meeting
Dr. Robert G. EcclesPresident, Advisory Capital PartnersSenior Fellow, PricewaterhouseCoopers
*connectedthinking
Page 2PricewaterhouseCoopers
Building Public Trust
Page 3PricewaterhouseCoopers
Issues for Your Consideration
The crisis in accounting (Building Public Trust)
Pressure for greater transparency (The ValueReporting Revolution)
A new approach to risk management (Enterprise Risk Management)
Will provide a quick overview of each
Will provide supporting material for each topic
Page 4PricewaterhouseCoopers
The Crisis in Accounting
Wave of accounting scandals (and failed governance) in the U.S. several years ago
Now seeing something similar in Europe (e.g., Adecco, Ahold, Parmalat)
U.S. response was Sarbanes-Oxley- Litigation was rushed in a very political environment- Has added significant compliance costs- Assumes the existing financial reporting model
Focus on earnings and the Earnings Game Regulatory filings rather than information used by management Higher penalties on executives for malfeasance Much tighter regulation of the accounting profession
Need to step back and take a broader view
Page 5PricewaterhouseCoopers
True Capital Market Reform Can Happen
Six key actions for restoring public trust and investor confidence:
1. Create principles-based global accounting standards
2. Develop additional industry-based performance information
3. Improve external reporting beyond regulatory requirements
4. Use the Internet to enhance performance reporting and analysis
5. Perform audits which present a “true and fair” view of the business
6. Strengthen all links in the Corporate Reporting Supply Chain
Page 6PricewaterhouseCoopers
Action #1 – Create Principles-based Global Accounting Standards
A global economy needs a global set of generally accepted accounting principles
Investors want to choose companies regardless of country
Companies want access to capital from all over the world
Global GAAP should be based on principles, not detailed rules
Get the “best of both worlds” between U.S. GAAP and International Financial Reporting Standards (IFRS)
Page 7PricewaterhouseCoopers
Company performance and future potential cannot be reduced to a single number (e.g., earnings or cash flow)
Global GAAP information must be supplemented with other financial (e.g., pro forma earnings) and nonfinancial information (e.g., customer retention)
A supplemental framework is needed
Each industry will develop standards within a Tier II framework
Action #2 – Develop Additional Industry-based Performance Information
Page 8PricewaterhouseCoopers
Action #2 – Develop Additional Industry-based Performance Information
An Example From Telecommunications And Pharmaceuticals
Page 9PricewaterhouseCoopers
Action #3 – Improve External Reporting Beyond Regulatory Requirements
Articulate the company’s “Holistic Story”
- Strategy and plans- Targets and benchmarks- Actual and desired risk profile and risk
management procedures- Internal control systems and
compliance programs- Compliance policies and programs- Principles of corporate governance- Compensation policies and amounts- Other performance metrics, including
company-specific ones- Commitments to other stakeholders
Page 10PricewaterhouseCoopers
The Corporate Reporting Transparency Framework
Page 11PricewaterhouseCoopers
Action #4 – Use the Internet to Enhance Performance Reporting and Analysis
Content and format are integrally linked
- Information is still largely provided in a clumsy paper-based format
- All this changes with Extensible Business Reporting Language (XBRL)
XBRL is a taxonomy for “tagging” information Provides the context for explaining what the information means XBRL enables obtaining information directly off the internet
- Microsoft, Nasdaq and PricewaterhouseCoopers have developed an XBRL demonstration site
www.nasdaq.com/xbrl 20 semi-conductor companies 5 years of data including income statement, balance sheet and footnotes.
Page 12PricewaterhouseCoopers
How XBRL Changes the Consumption of Corporate Reports
Action #4 – Use the Internet to Enhance Performance Reporting and Analysis
Page 13PricewaterhouseCoopers
Action #5 – Perform Audits Which Present a “True and Fair” View of the Business
Today’s audit opinion is about the financial position of the company
- Accounting and auditing standards vary by country- Historical financial statements are an incomplete picture - An “Expectations Gap” exists about what an audit opinion really
means- The audit needs to stand for more- Issues around risk and liability will need to be addressed
Page 14PricewaterhouseCoopers
Action #6 – Strengthen all Links in the Corporate Reporting Supply Chain
Every Group Must Take Responsibility for Improving our Markets
Page 15PricewaterhouseCoopers
Action #6 – Strengthen all Links in the Corporate Reporting Supply Chain
The Need for Better Corporate Governance
Directors need to remember that they represent shareholders
Much of the current focus is on structural reforms
Equally important are issues of qualifications, process, resources and compensation
Legislation and regulation should be balanced with market forces
Page 16PricewaterhouseCoopers
ValueReporting
Page 17PricewaterhouseCoopers
Pressures for Greater Transparency
Roughly two-thirds of CEOs think their company’s shares are undervalued
Market sets price based on information- Companies are not reporting information they regard as useful in running the company- Analysts and investors agree that they are not getting this information- Audit Committees say they are not getting this information
ValueReporting is about greater transparency by companies- Financial and nonfinancial information- Tangible and intangible assets- Integrated perspective on risk and strategy- Market rather than regulatory driven
Benefits of greater transparency- More accurate stock price- Better managed company- A way to move beyond the Earnings Game
PricewaterhouseCoopers
Companies create sustainable economic value by developing, operationalizing and executing superior strategies which guide the company towards delivering valuable products and services.
These strategies yield future cash flows greater than investment or economic profit.
Companies ensure that investors realize the value created by the business units and the corporate center by managing and delivering upon market expectations.
Companies preserve the value of the underlying business unit cash flows through effective management controls, risk and tax management.
Value
Creation
Value
Preservation
Value
RealizationInvestmentCommunityCompanies
A Better Managed Company
Why Is ValueReporting Important?
Page 19PricewaterhouseCoopers
Performance Measures and the Utility Industry
Utility CFOs’ perceptions of whether the market properly values their company
0
10
20
30
40
50
60
Strongly Over-Values
Company
Tends toOver-ValueCompany
About Right Tends toUnder-Value
Company
StronglyUnder-Values
Company
No Opinion
Source: 1999 PricewaterhouseCoopers Capital Markets Survey
Page 20PricewaterhouseCoopers
How Actively a Measure is Communicated
Importance of a Measure
Reporting Gap Information Gap
Perception Gap
Understanding Gap
Quality of Information
Quality Gap
Communication gaps prevent market value from reflecting underlying value
Management’s Valuation
Investors/Analysts
Market Value
Value gap
How Adequately a Measure is Communicated
Importance of a Measure
Performance Measures and the Utility Industry
Page 21PricewaterhouseCoopers
Performance Measures & the Utility Industry
High Importance Medium Importance Low Importance
CFOs’ Perceptions of the Relative Importance of Performance Measures
Utility CFOs recognize that a broad range of financial and non-financial measures are useful for managing their companies
Source: 1999 PricewaterhouseCoopers Capital Markets Survey
1. Regulatory environment and price controls
1. Quality of management
2. Cost reduction
3. Investment/acquisition strategy
4. Operating profit growth
5. Operating cash flow growth
6. Market growth
7. Strategic direction and focus - integrated v specialist player
8. Risk management processes
9. Margin improvements
10. Brand value/reputation
11. Environmental strategy, performance and cost
12. Geographic focus/exploiting changing markets
1. Market share/position
2. Revenue growth from new services/ geographies/customers
3. Extent of competition/ barriers to entry
Page 22PricewaterhouseCoopers
1. Brand value/reputation
2. Cost reduction
3. Extent of competition/ barriers to entry
4. Geographic focus/ exploiting changing markets
5. Investment/acquisition strategy
6. Margin improvements
7. Market growth
8. Market share/position
9. Operating cash flow growth
10. Operating profit growth
1. Cost reduction
2. Extent of competition/ barriers to entry
3. Geographic focus/ exploiting changing markets
4. Investment/acquisition strategy
5. Margin improvements
6. Market growth
7. Market share/position
8. Operating cash flow growth
9. Operating profit growth
10. Quality of management
Measure ranked as top ten by investors and/or analysts but not by companies. These data are for general utility companies. Data are also available for generators, retailers and network companies.
The Top Ten Performance Measures Utility Industry
Perceptions of the Relative Importance of Performance Measures
Companies Investors Analysts
1. Regulatory environment and price controls
2. Quality of management
3. Cost reduction
4. Investment/acquisition strategy
5. Operating profit growth
6. Operating cash flow growth
7. Market growth
8. Strategic direction and focus - integrated v specialist player
9. Risk management processes
10. Margin improvements
Page 23PricewaterhouseCoopers Quality Gap
Information, Reporting and Quality Gaps in the Utility Industry
Companies Analysts Investors
Information Gap #
Companies
Reporting Gap#
# Gap exists when the difference is equal or greater than 20 percent.
Performance Measures
1. Regulatory environment and price controls
2. Quality of management
3. Cost reduction
4. Investment/acquisition strategy
5. Operating profit growth
6. Operating cash flow growth
7. Market growth
8. Strategic direction and focus - integrated v specialist player
9. Risk management processes
10. Margin improvements
1. Regulatory environment and price controls
2. Quality of management
3. Cost reduction
4. Investment/acquisition strategy
5. Operating profit growth
6. Operating cash flow growth
7. Market growth
8. Strategic direction and focus - integrated v specialist player
9. Risk management processes
10. Margin improvements
Page 24PricewaterhouseCoopers
Enterprise Risk Management
Page 25PricewaterhouseCoopers
A New Approach to Risk Management
Enterprise risk management is a process, effected by an entity’s board of directors, management, and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity and manage risks to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives
Committee of Sponsoring Organizations (COSO) initiated a project on enterprise risk management
- Next “Big Thing” after Internal Controls – an Integrated Framework- Draft report has been put out for public exposure and comments received- Final report and application guidance will be published this summer
PricewaterhouseCoopers’ CEO Survey (1391 CEOs)- Basic processes in place- Much less progress on “full implementation”- Benefits are very real- Barriers are significant- Two main strategies exist for making real progress
Page 26PricewaterhouseCoopers
The Committee of Sponsoring Organizations Enterprise Risk Management Framework
* The Committee of Sponsoring Organizations Enterprise Risk Management Framework
- Forms the framework for Sarbanes-Oxley
- Activities are considered at all levels of the organization
COSO* ERM
Page 27PricewaterhouseCoopers
Which of the following processes does your organization have in place?
Basic Processes of ERM
Page 28PricewaterhouseCoopers
To what extent do you agree or disagree with the following statement regarding regulatory compliance?
Basic Processes of ERM — Compliance
Page 29PricewaterhouseCoopers
Elements of Full ERM Implementation
To what extent do you agree or disagree with each of the following statements regarding risk management and ERM?
Page 30PricewaterhouseCoopers
To what extent do you agree or disagree with each of the following statements regarding risk management?
Levels of Commitment
Page 31PricewaterhouseCoopers
Which of the following are key challenges that restrict your organization in identifying and managing enterprise-wide risks, and which is most challenging?
Challenges To Implementation
Page 32PricewaterhouseCoopers
To which of the following groups do you periodically report your company’s enterprise-wide risk portfolio, and how often does this occur?
Reporting Risk Profile
Page 33PricewaterhouseCoopers
Percentage reporting strong or considerable positive impact
Benefits of ERM
Page 34PricewaterhouseCoopers
When would you expect your organization to have effective and efficient ERM in place?
Is ERM in Place?
Page 35PricewaterhouseCoopers
When ERM is a CEO priority Percentage reporting strong or considerable positive impact
Full ERM Implementation
Page 36PricewaterhouseCoopers
When ERM is a CEO priority
Challenges
Page 37PricewaterhouseCoopers
When ERM is a CEO priorityPercentage reporting strong or considerable positive impact
Benefits of ERM
Page 38PricewaterhouseCoopers
When ERM is integrated in strategic planningPercentage reporting strong or considerable positive impact
Full ERM Implementation
Page 39PricewaterhouseCoopers
When ERM is integrated in strategic planning
Challenges
Page 40PricewaterhouseCoopers
When ERM is integrated in strategic planning
Percentage reporting strong or considerable positive impact
Benefits of ERM
Page 41PricewaterhouseCoopers
CEO priority advanced practitioners
Percentage reporting strong or considerable positive impact
Full ERM Implementation
Page 42PricewaterhouseCoopers
CEO priority advanced practitionersPercentage reporting strong or considerable positive impact
Benefits of ERM
Page 43PricewaterhouseCoopers
Strategic planning advanced practitioners
Percentage reporting strong or considerable positive impact
Full ERM Implementation
Page 44PricewaterhouseCoopers
Strategic planning advanced practitioners
Percentage reporting strong or considerable positive impact
Benefits of ERM
Page 45PricewaterhouseCoopers
Action Items
Establish one or more industry-based consortia to establish Tier-Two Standards for non-GAAP information
- Include all relevant members the Corporate Reporting Supply Chain- Will be adopted on a voluntary basis: let the market decide
Determine and implement optimal level of transparency- Do a company-specific “ValueReporting” Survey- Establish a process that involves senior management and the Board
Design and implement a process for enterprise risk management
- Do a self-diagnosis based on questions in CEO survey- Read COSO report when it is published this summer
More information can be found at www.pwc.com or from [email protected]